Innovation & Strategy MODULE 4

Formulation
Gospel Reading

“Forget the former things; do not dwell on the past. See, I am doing a new thing! Now it springs up; do you not
perceive it?
I am making a way in the wilderness and streams in the wasteland”
Isaiah 43:18-19

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Learning Objectives

Illustrate the strategy concepts on

The ‘Five Forces’ that shape strategy.

Discuss the cornerstones of

competitive advantage

Explain resource accumulation

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Module Overview

This module will help identify and evaluate strategies and structures that are more
likely to lead to success. Michael Porter’s Five Forces will be the main tool to be used
for Industry Analysis

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What is Business Strategy

Strategy is the pattern of decisions any company that determines and reveals its objectives, purposes,
or goals, produces the principal policies and plans for achieving these goals, and defines the range of
business the company is to pursue; the kind of economic and human organization it is or intends to
be, and the nature of the economic and noneconomic contribution it intends to make to its
shareholders, employees, customers, and communities

Kenneth Andrews, The concept of Corporate Strategy (Homewood, IL: Richard D. Irwin, 1971)

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Fundamental Principle of Business Strategy

"If everyone can do it, it's difficult to create and capture value
from it."
or alternatively

"In a perfectly competitive market, no firm realizes economic

profits (rents)"

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 The Role of
Industry Stucture
 Premise that industry structure matters
most
 Economic rents due to barriers to
competition (i.e. monopoly rents)
 Some industies are more profitable than
others

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Industry
Average ROA
Different Industries have different
ROAs

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Five Porter's Analysis
Threat of new
entrant

Bargaining
Bargaining Intensity of
Power of
Power of Buyer Rivalry Supplier

Threat of
Substitute
Products

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Threat of New Entry

Barriers to Entry
1.Economies of Scale
2.Product Differentiation
(Competitive Advantage)
3.Capital Requirements
4.Cost disadvantages independent
of size
5.Access to distribution channel
6.Government policy
7.Threat of retaliation
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Competitive Advantage

 Patents and Licenses

 Pioneering Brands
 Large economies of scale (relative to demand)
 Pre-commitment contracts
 Steep learning (experience curves)

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Likelihood of Retaliation

 Excess Capacity of Incumbents

 Economies of Scale
 Substantial exit cost
 Aggressive reputation of incumbents

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Bargaining Power of Supplier

Supplier is powerful if:

1. Dominated by few companies
2. Product is unique / differentiated, high
switching cost
3. Not obliged to contend with other products
for sale to the industry
4. Credible threat to do forward integration
5. Industry is not an important customer of
the supplier group

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Supplier are less of a Threat when

 Sellers are not concentrated (no monopoly)

 Firms have many alternatives
 Many substitutes for suppliers products
 Firms faces low switching cost
 Supplier cannot forward integrate

 Sellers may not treat segments differently

 Price information is widely available
 Price discrimination is not possible

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Bargaining Power of Buyer

Buyer is Powerful if:

1. Purchase in bulk volume
2. Products it purchases from the industry form a
component of its product and it represents
significant fraction of its cost
3. Earns low profits, which create greater incentive to
lower its purchasing cost
4. Industry’s product is unimportant to the quality of
buyers’ products or services
5. Industry’s product does not save the buyer money
6. Buyer can do backward integration

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Buyers have less power if

1. Buyers are not concentrated (no monopsony)

◦ Many potential buyers
◦ Each accounts for a small fraction of sales

2. Buyers have few options

• products are differentiated
• high switching cost
• buyer cannot backward integrate

3. Buyers are segmented

• Price information is not widely available
• Price discrimination possible
• Bundling possible

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Strategic Action to Address Supplier and Buyer’s Bargaining
Power

 A company can improve its strategic posture by finding suppliers or buyers who possess the least power
to influence it adversely.
 Most common is the situation of a company being able to choose whom it will sell to – buyer selection
 A company can sell to powerful buyers and still come away with above-average profitability only if it is
a low-cost producer in its industry or if its product enjoys some unusual, if not unique, features
 If company lacks a low cost position or a unique product, selling to everyone is self-defeating because
the more sales it achieves, the more vulnerable it becomes
 Buyer selection can help a company focus on the segments of the industry where they can create
product differentiation, minimize threat of backward integration, or mitigate the power of their customers

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Threat of Substitute Products

Substitute Products –

Threat of substitute is low:

o Cross-price elasticity of demand is low
o Switching costs are high

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Cross-Price Elasticity

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Intensity of Rivalry

Rivalry is high if:

 Competitors are numerous or are roughly equal in
size and power
 Industry growth is slow (mature market)
 Product lacks differentiation or switching cost
 Fixed cost is high or product is perishable, creating
strong temptation to cut prices
 Capacity is augmented in large increments
 Exit barriers are high
 Rivals are diverse in strategies, origins, and
personalities

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Cornerstones of Competitive Advantage

Heterogeneity
Heterogeneity

Rents
(Monopoly or
or Ricardian)
Ricardian)

Ex
Ex Post
Post Limits
Limits
Imperfect
Imperfect Competitive to
Mobility to
Mobility Advantage Competition
Competition

Rents Sustained within the firm Rents Sustained

Ex
Ex Ante
Ante Limits
Limits
to
to
Competition
Competition
Rents not offset by cost

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Resource Accumulation

Resource based model fundamentally concerned with internal accumulation of

assets, asset specificity, and less directly with transaction costs

Barney (1988) – abnormal returns from diversification depend on how rare and
imitable resulting combination of resources

Montgomery and Hariran (1991) shown that firms with broad resource bases tend to
pursue diversification

Theory of diversification is resource based – diversification is the result of excess

capacity in which resources have multiple uses and for which there is market failure

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Application – Resource Accumulation

Montgomery & Wernerfelt (1989) diversification viewed as matching a firm’s

resources to the set of market opportunities

Firms with more specialized resources are more constrained to enter into
widely different product markets – and specialized resources relatively scarce,
thus higher rents

Firms with more generalizable resources may face a wide opportunity set –
yet lower rents

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Thank You!